Judges: "Swift, Stephen J"
Attorneys: John M. Olivieri and Mark D. Allison , for the estate. Lydia Branche and Shawna Early , for respondent.
Filed: Jan. 29, 2009
Latest Update: Dec. 05, 2020
Summary: T.C. Memo. 2009-21 UNITED STATES TAX COURT ESTATE OF MARJORIE DEGREEFF LITCHFIELD, DECEASED, GEORGE B. SNELL AND PETER DEGREEFF JACOBI, COEXECUTORS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 15882-05. Filed January 29, 2009. John M. Olivieri and Mark D. Allison, for the estate. Lydia Branche and Shawna Early, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION SWIFT, Judge: Respondent determined a $6,223,176 Federal estate tax deficiency with respect to the estat
Summary: T.C. Memo. 2009-21 UNITED STATES TAX COURT ESTATE OF MARJORIE DEGREEFF LITCHFIELD, DECEASED, GEORGE B. SNELL AND PETER DEGREEFF JACOBI, COEXECUTORS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 15882-05. Filed January 29, 2009. John M. Olivieri and Mark D. Allison, for the estate. Lydia Branche and Shawna Early, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION SWIFT, Judge: Respondent determined a $6,223,176 Federal estate tax deficiency with respect to the estate..
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T.C. Memo. 2009-21
UNITED STATES TAX COURT
ESTATE OF MARJORIE DEGREEFF LITCHFIELD, DECEASED, GEORGE B. SNELL
AND PETER DEGREEFF JACOBI, COEXECUTORS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15882-05. Filed January 29, 2009.
John M. Olivieri and Mark D. Allison, for the estate.
Lydia Branche and Shawna Early, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined a $6,223,176 Federal
estate tax deficiency with respect to the estate of decedent
Marjorie deGreeff Litchfield (the estate).
After agreement by the parties as to the fair market value
of many assets of the estate, the issues for decision involve the
percentage discounts that should be used for built-in capital
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gains taxes, for lack of control, and for lack of marketability
relating to the estate’s minority interests in two closely held
family corporations.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect on the October 17, 2001,
alternate valuation date, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
Decedent, Marjorie deGreeff Litchfield, died on April 17,
2001, a resident of Katonah, New York. At the time of filing the
petition, George B. Snell, coexecutor of the estate, lived in New
Jersey, and Peter deGreeff Jacobi, the other coexecutor of the
estate, lived in North Carolina.
Under section 2032(a)(2) the estate elected the October 17,
2001, alternate valuation date (the valuation date).
Decedent’s husband, Edward S. Litchfield, had died in 1984.
On the date of his death, decedent’s husband owned minority stock
interests in two closely held family-owned corporations named
Litchfield Realty Co. (LRC) and Litchfield Securities Co. (LSC).
In his will, a qualified terminable interest property
election was made by decedent’s husband under section 2056(b)(7),
and the shares of LRC and LSC stock owned by decedent’s husband
transferred upon his death tax free under the marital deduction
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to a lifetime income residuary trust in favor of decedent that
had been established in 1984 (the trust). For Federal estate tax
purposes, under section 2044 decedent’s estate is required to
include in her gross estate the fair market value of the LRC and
LSC stock owned by the trust.
LRC
In 1921 LRC was incorporated in Delaware as a C corporation
to invest in and to manage farmland and other assets of the
Litchfield family in Iowa. From 1921 until 1984, all outstanding
shares of LRC stock were owned by members of the Litchfield
family. After the trust was established in 1984, all outstanding
shares of LRC stock were owned by members of the Litchfield
family and by the trust.
As of the valuation date, LRC had approximately 18
shareholders, and decedent’s estate owned directly and indirectly
through the trust a total of 215,556 shares of LRC stock or 43.1
percent of the 500,000 shares of LRC stock outstanding.
The table below identifies LRC’s board of directors and
officers and briefly describes their investment experience as of
the valuation date:
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Name Director Office Held Investment Experience
Phillip Litchfield Chairman -- --
Kurt Olson Yes President --
Michael deMilt Yes Asst. treasurer CPA and CFA
Ward Hunter No VP & treasurer --
John Kaufman Yes Asst. secretary --
Michael Larned Yes Asst. treasurer Experienced investor
Christopher Litchfield No Secretary Manager of hedge
fund
Eric Litchfield Yes Asst. secretary --
Pieter Litchfield Yes Asst. treasurer --
Amy Webber No Asst. secretary --
In 1921 when LRC was formed, Litchfield family members
contributed to LRC farmland in return for shares of LRC stock.
Over the years, LRC has leased its Iowa farmland to local farmers
under share-lease agreements.1
As of the valuation date, LRC’s assets consisted largely of
farmland and marketable securities, and LRC also owned a
subsidiary corporation that owned and operated a public grain
elevator and that sold to farmers crop insurance and services
1
Under Iowa share-lease agreements, LRC leases farmland to
local tenant farmers, pays the farmers a share of the crop’s
planting costs, and receives a share of the proceeds when the
crops are sold. Under Iowa law, restrictions apply to corporate
ownership of farmland. Because LRC was formed for an
agricultural purpose and because only Litchfield family members
and the trust own shares in LRC, LRC qualifies as an Iowa family
farm corporation and is permitted to own farmland. Iowa Code
Ann. secs. 9H.1(8), 9H.4 (West 2001).
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such as pesticide and fertilizer applications. LRC’s assets had
a total net asset value of $33,174,196--$23,422,439 in farmland
and related equipment and supplies and $9,751,757 in marketable
securities.2
Although LRC’s earnings each year reflected a marginal
profit, in 2001 and for many prior years LRC had not been
performing as well as expected by LRC management and
shareholders. During the 1990s mid-western farmland consistently
had an annual income yield of over 4 percent of net asset value.
LRC’s farmland generally had an annual income yield of less than
1 percent.
2
Per a stipulation of the parties, as of the Oct. 17, 2001,
valuation date LRC’s assets, liabilities, and net asset value are
listed below:
Assets: Fair Market Value
Real estate $22,671,055
Marketable securities 9,751,757
Mineral rights 319,942
Subsidiary 300,000
Grain inventory 244,122
Prepaid expenses 156,304
Machinery, equipment, and vehicles 132,782
Cash 39,414
Co-op dividends 31,970
Receivables (25,062)
Liabilities (448,088)
Net asset value $33,174,196
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On January 1, 2000, LRC elected to convert from a C
corporation to an S corporation. LRC management anticipated that
pass-through taxation would result in increased profitability and
better returns for LRC shareholders. However, if before
January 1, 2010 (10 years from the first day of the first taxable
year for which LRC elected S corporation status), LRC sold assets
that it owned before its January 1, 2000, S election, LRC would
incur corporate-level tax on the sale of those assets. See sec.
1374.
Before the valuation date, LRC management determined that
straight cash leases with local farmers probably would provide a
better return than share-lease agreements. However, because
income from straight cash leases typically constitutes passive
income and because LRC management did not want to trigger a
corporate-level tax on passive income in excess of 25 percent of
gross receipts, see sec. 1375, as of the valuation date LRC had
not yet started using straight cash leases for its farmland.
Since 1921, LRC occasionally has sold portions of its
farmland to raise cash.
LSC
In 1924 LSC was incorporated in Delaware as a C corporation
to invest in marketable securities. Litchfield family members
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contributed marketable securities they owned to LSC in return for
shares of LSC stock.
As of the valuation date, LSC had approximately 50
shareholders, and all shareholders were members of the Litchfield
extended family or the trust. As of the valuation date,
decedent’s estate owned directly and indirectly through the trust
38,808 shares of LSC stock or 22.96 percent of the 168,990 shares
of LSC stock outstanding.
The table below identifies LSC’s board of directors and
officers and briefly describes their investment experience as of
the valuation date:
Name Director Office Held Investment Experience
Michael Larned Chairman President Experienced investor
Michael deMilt Yes VP & treasurer CPA and CFA
John Kaufman Yes Secretary --
Christopher Litchfield Yes -- Manager of hedge fund
Brian Morris Yes -- --
Ann Theurer -- Asst. secretary --
Mr. Larned made recommendations to LSC management as to
which stocks should be bought and sold and when.
As of the valuation date, LSC’s assets included blue-chip
marketable securities (e.g., AT&T, DuPont, and IBM) as well as
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partnership and other equity investments, and LSC had a combined
net asset value of $52,824,413.3
Over the years, LSC’s investment strategy focused on
maximizing cash dividends to shareholders, and cash dividends
paid to LSC shareholders increased consistently.
No shares of LRC or LSC stock have ever been sold on the
open market. LRC’s and LSC’s stock transfer policies generally
discouraged stock redemptions and sales to outsiders.
On February 8, 2000, after LRC became an S corporation, LRC
shareholders executed a shareholder agreement under which
shareholders were prohibited from making stock transfers that, in
the opinion of counsel for the corporation, would jeopardize
LRC’s S corporation status or its Iowa family-farm corporation
status. Also, LRC maintained a right of first refusal to buy any
LRC stock a shareholder wished to sell.
However, in the late 1990s Mr. deMilt (as an officer and
director of LRC and LSC, as a trustee of the trust, and as part
3
Per a stipulation of the parties, as of the Oct. 17, 2001,
valuation date, LSC’s assets, liabilities, and net asset value
are listed below:
Assets: Fair Market Value
Marketable securities $49,970,382
Cash 2,088,572
Equity investments 685,108
Short-term investments 100,000
Federal income tax receivable 1,500
Liabilities (21,149)
Net asset value $52,824,413
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of his duties with an investment management company which advised
LRC and LSC) became concerned that the trust consisted of
illiquid LRC and LSC shares and that decedent and several other
elderly LRC and LSC shareholders did not have adequate cash for
payment of estate taxes and other obligations upon their deaths.
By the late 1990s Mr. deMilt and other officers of LRC and LSC
contemplated sales of LRC and LSC corporate assets to finance
stock redemptions whereby elderly LRC and LSC shareholders would
receive cash needed to pay estate taxes and other obligations.
Mr. deMilt and LRC management requested studies of the
feasibility of selling parcels of LRC farmland to outsiders.
After the valuation date LRC sold a farm services subsidiary and
shut down a public grain elevator that LRC had been attempting to
sell for some time. By 2000 a number of mergers of public
companies, stock of which was included in the LRC and LSC
security portfolios, anticipated mergers, and corporate
reorganizations that likely would follow from the mergers were
anticipated to result in the sale or transfer by LRC and LSC of
significant appreciated securities they held.
As of the valuation date, LRC’s $33,174,196 net asset value
included $28,762,306 in built-in capital gains--86.7 percent of
LRC’s total net asset value, and $19,789,772 of which related to
the farmland and real property LRC owned and $8,972,534 of which
related to marketable securities LRC owned.
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As of the valuation date, LSC’s $52,824,413 net asset value
included $38,984,799 in built-in capital gains--73.8 percent of
LSC’s total net asset value.
As of the valuation date, the capital gains tax rate
applicable to LRC and to LSC was between 35.5 and 39.1 percent.
See sec. 1(i)(2).4
Estate Tax Return
In connection with the preparation of the estate’s Federal
estate tax return, the estate’s valuation expert prepared a
valuation report in which he discounted the estate’s 43.1-percent
stock interest in LRC by 17.4 percent for built-in capital gains
taxes, by 14.8 percent for lack of control, and by 36 percent for
lack of marketability, and in which he opined that the estate’s
interest in LRC had a valuation date fair market value of
$6,475,000.
With regard to the estate’s stock interest in LSC, the
estate’s valuation expert prepared a report in which he
discounted the estate’s 22.96-percent stock interest in LSC by
23.56 percent for built-in capital gains taxes, by 11.9 percent
for lack of control, and by 29.7 percent for lack of
4
As indicated, as an S corporation LRC would be subject to
corporate capital gains taxes on the sale before Jan. 10, 2010,
of assets owned before its Jan. 1, 2000, S election. See sec.
1374.
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marketability, and in which he opined that the estate’s interest
in LSC had a valuation date fair market value of $5,748,000.
On June 27, 2002, the estate’s Federal estate tax return
was filed, reporting the estate’s respective interests in LRC and
in LSC at the above values, a total taxable gross estate of
$56,057,800, a total Federal estate tax liability of $22,396,609,
and a $3,391 overpayment as a result of $22.4 million in
estimated Federal estate taxes the estate had paid.
Respondent’s Audit
On March 21, 2003, respondent’s estate tax examiner mailed
to the estate a request for documents and scheduled an April 17,
2003, initial audit meeting with the estate’s coexecutors and
legal representatives regarding the estate’s Federal estate tax
liability. In his letter, respondent’s estate tax examiner
requested that the estate make available for his review LRC’s and
LSC’s financial statements, tax returns, dividends paid,
officers’ salaries, shares outstanding, and shareholder names.
At the April 17, 2003, meeting the estate’s representatives
made available to respondent’s estate tax examiner for review
most of the financial information and documents requested.
Because the financial information and documents made available to
him were voluminous, at the conclusion of the meeting
respondent’s estate tax examiner did not take the documents with
him, and he did not make copies of the documents he had reviewed.
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Instead, respondent’s estate tax examiner asked the estate’s
representatives to make copies of all of the documents and to
mail the copies to him at his local Government office and to
include in the mailing any documents not previously made
available for review--apparently some financial documents
relating to LRC and LSC. Soon thereafter, one of the estate’s
representatives had serious medical problems and was not able to
supervise the preparation and mailing to respondent of the
requested documents. However, other representatives of the
estate stepped in and mailed to respondent’s estate tax examiner
copies of documents that had been requested. Transmittal letters
included with the documents mailed to respondent identified and
listed the documents that purportedly were included with the
mailing--specifically listing the financial documents relating to
LRC and LSC.
At the conclusion of the audit, on June 14, 2005, respondent
issued to the estate a notice of deficiency in which respondent
valued the estate’s interests in LRC at $10,300,207 ($3,825,207
more than reported by the estate) and the estate’s interest in
LSC at $8,762,783 ($3,014,783 more than reported by the estate),
and in which respondent determined a $6,223,176 Federal estate
tax deficiency.
On April 5, 2007, in a meeting with respondent’s and the
estate’s representatives just a few days before the start of the
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trial herein, respondent’s estate tax examiner informed the
estate’s representatives for the first time that he believed he
had never received delivery from the estate of copies of certain
LRC and LSC financial documents he had requested at the April 17,
2003, initial audit meeting.
OPINION
Burden of Proof
Under section 7491(a), the burden of proof on factual issues
may shift from a taxpayer to respondent where a taxpayer complied
with substantiation requirements, maintained records, cooperated
with respondent’s reasonable requests for witnesses, information,
documents, meetings, and interviews, and introduced credible
evidence. Sec. 7491(a)(1) and (2)(A) and (B); Rule 142(a)(2).
Respondent acknowledges that the estate generally complied
with all substantiation, record maintenance, and cooperation
requirements of section 7491(a)(2), but respondent argues that a
shift in the burden of proof in this case from the estate to
respondent on the factual valuation issues should not occur
because the estate did not timely mail to respondent copies of
certain requested LRC and LSC financial documents and because the
estate has not introduced credible evidence as to the discounts
to be applied to LRC’s and LSC’s net asset values.
With regard to the documents, respondent’s estate tax
examiner states that he was aware throughout the audit that he
- 14 -
had not received from the estate copies of some of the LRC and
LSC financial documents he had requested in March of 2003, but he
explains that he did not bring the documents again up with the
estate’s representatives, ask for them again, or complain about
their nonproduction until just before the start of the April 2007
trial because one of the estate’s representatives was ill, and he
(the examiner) did not want to make a fuss or appear to be
bullying the estate’s representatives.
The estate’s representatives assert that copies of all
requested LRC and LSC documents were timely mailed to
respondent’s estate tax examiner in the spring of 2003 and that
the failure of respondent’s examiner to communicate to the
estate’s representatives any complaint about the estate’s
document production until just a few days before the start of the
trial is inexcusable. The estate, of course, also contends that
credible evidence has been submitted in support of the estate’s
claimed discounts to LRC’s and LSC’s net asset values.
In view of respondent’s dilatory complaint, it is
respondent’s contention that is not credible as to the estate’s
alleged lack of production of LRC and LSC financial documents.
With regard to credible evidence on the factual discount
issues, as discussed below, the trial evidence the estate
submitted certainly so qualifies. The estate qualifies for the
shift in the burden of proof under section 7491(a)(1) on the
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factual issues as to the appropriate discounts for built-in
capital gains taxes, for lack of control, and for lack of
marketability.5
Other arguments respondent makes on the burden of proof
issue were raised late, have been considered, and are found to be
without merit.6
Valuation
For Federal estate tax purposes, the value of a decedent’s
gross estate includes the fair market value of all property owned
by the decedent’s estate. Sec. 2031; sec. 20.2031-1(b), Estate
Tax Regs. Property to be included in the estate includes assets
transferred tax free under a marital deduction from a predeceased
spouse to a trust giving life income to the decedent. See sec.
2044.
5
We note that in some cases involving the valuation of
property where all of the operative facts are stipulated and are
supplemented at trial only by expert witness testimony, placement
of the burden of proof may be treated as irrelevant. See, e.g.,
Estate of Jelke v. Commissioner, T.C. Memo. 2005-131, vacated and
remanded on other aspects of the valuation issue, 507 F.3d 1317
(11th Cir. 2007). In the instant case, not all operative facts
were stipulated, important operative facts were hotly contested
at trial, and the factual valuation issues in this case are
subject to a shift in the burden of proof under sec. 7491.
6
At trial or on brief, respondent for the first time argues
that the estate’s appraised value for some artwork, the value of
which was settled before trial, should constitute a bar to a
shift in the burden of proof on the LRC and LSC valuation issues.
- 16 -
Fair market value is defined as the hypothetical price at
which a willing buyer and a willing seller, under no compulsion
to buy or sell and both possessing reasonable knowledge of
relevant facts, would enter into a hypothetical sale and purchase
of the property to be valued. United States v. Cartwright, 411
U.S. 546, 551 (1973) (quoting sec. 20.2031-1(b), Estate Tax
Regs.); Estate of Newhouse v. Commissioner,
94 T.C. 193, 217
(1990).
A determination of the fair market value of property
generally involves questions of fact. CSX Transp. Inc. v. Ga.
State Bd. of Equalizaton, 552 U.S. ___, ___ (2007), 128 S. Ct.
467, 473 (2007). Treasury regulations expressly provide that for
Federal estate tax purposes the valuation of property involves a
fact-based inquiry that is to take into account “All relevant
facts and elements of value”. Sec. 20.2031-1(b), Estate Tax
Regs.
In CSX Transp. Inc., the U.S. Court of Appeals for the
Eleventh Circuit had upheld as a matter of law a State-mandated
particular valuation methodology for railroad real property. CSX
Transp. Inc. v. Ga. State Bd. of Equalization, 472 F.3d 1281
(11th Cir. 2006). In reversing, the Supreme Court elaborated on
the factual nature of property valuation issues as follows:
- 17 -
Valuation is not a matter of mathematics * * *.
Rather, the calculation of true market value is an
applied science, even a craft. Most appraisers
estimate market value by employing not one methodology
but a combination. These various methods generate a
range of possible market values which the appraiser
uses to derive what he considers to be an accurate
estimate of market value, based on careful scrutiny of
all the data available. * * *
* * * * * * * *
Appraisers typically employ a combination of
methods because no one approach is entirely accurate,
at least in the absence of an established market for
the type of property at issue. The individual methods
yield sometimes more, sometimes less reliable results
depending on the peculiar features of the property
evaluated. * * *
* * * * * * *
Valuation of property, though admittedly complex,
is at bottom just “an issue of fact about possible
market prices,” Suitum v. Tahoe Regional Planning
Agency, 520 U.S. 725, 741,
117 S. Ct. 1659,
137 L. Ed. 2d
980 (1997), an issue * * * courts are used to
addressing. * * * [CSX Transp., Inc. v. Ga. State Bd.
of Equalization, 552 U.S. at ___, ___, 128 S. Ct. at
472-473.]
See also Gross v. Commissioner, 272 F.3d 333, 343 (6th Cir. 2001)
(“choice of the appropriate valuation methodology for a
particular stock is, in itself, a question of fact”), affg. T.C.
Memo. 1999-254; Estate of O’Connell v. Commissioner,
640 F.2d
249, 251-252 (9th Cir. 1981) (trial court has “broad discretion
in determining what method of valuation most fairly represents
the fair market value * * * in view of the facts presented at
trial”), affg. in part and revg. and remanding in part T.C. Memo.
- 18 -
1978-191; Silverman v. Commissioner, 538 F.2d 927, 933 (2d Cir.
1976) (trial court’s method for valuing stock did not deprive the
donor of due process because “Such a [factual] determination is
one that is entitled to be made on all the elements of the
particular case” (quoting Heil Beauty Supplies, Inc. v.
Commissioner,
199 F.2d 193, 195 (8th Cir. 1952), affg. a
Memorandum Opinion of this Court)), affg. T.C. Memo. 1974-285.
As stated in Rev. Rul. 59-60, secs. 3-5, 1959-1 C.B. 237,
238-242, a hypothetical purchase price (i.e., fair market value)
is to be determined through a commonsense application of all the
relevant facts and circumstances with appreciation for the fact
that valuation is an inexact science.
We emphasize that resolution of valuation issues typically
involves an approximation--by the parties, by the experts, and
also by the courts--and that a court’s valuation need not be tied
to specific testimony or evidence if it is within the range of
values supported by the evidence. Estate of Davis v.
Commissioner, 110 T.C. 530, 537 (1998); Peracchio v.
Commissioner, T.C. Memo. 2003-280.
As indicated, different valuation methods may be used in
calculating fair market value of stock in closely held
corporations. The market method (or comparable company analysis)
compares a closely held company with an unknown stock value to
similar companies with known stock values. The income (or
- 19 -
discounted cashflow) method discounts to present value
anticipated future income of the company whose stock is being
valued. The net asset value (or balance sheet) method relies
generally on the net asset value of the company. See Estate of
Noble v. Commissioner, T.C. Memo. 2005-2.
With respect to stock in closely held real estate holding
companies and investment companies such as LRC and LSC, the net
asset valuation method is often accepted as the preferred method.
Estate of Smith v. Commissioner, T.C. Memo. 1999-368; Estate of
Ford v. Commissioner, T.C. Memo. 1993-580, affd. 53 F.3d 924 (8th
Cir. 1995); Rev. Rul. 59-60 at sec. 5(b), 1959-1 C.B. 243.
The parties’ experts used the net asset valuation method in
their appraisals of the fair market value of the estate’s
minority LRC and LSC stock interests. The parties’ experts apply
discounts to LRC’s and LSC’s net asset values to reflect the
substantial built-in capital gains taxes that, as of the
valuation date, were associated with LRC’s and LSC’s appreciated
assets. A hypothetical buyer would be willing to pay fair market
value for the LRC and LSC stock, which would take into account
and would reflect the millions of dollars in untaxed appreciation
over the years in the values of LRC’s and LSC’s underlying
assets. Knowledgeable buyers, however, also would negotiate
discounts in the price of the stock to estimate, on the basis of
current tax laws, the corporate capital gain tax liabilities due
- 20 -
on that very same appreciation when the assets are sold or
otherwise disposed of by the corporation. In other words, if a
valuation of or price for corporate stock in a hypothetical sale
is significantly affected by the untaxed appreciated value of the
underlying corporate assets, the stock valuation or hypothetical
stock price also should reflect the corporate capital gains tax
liabilities that the appreciated assets carry with them and that
will be paid by the corporation upon sale or other disposition of
the assets. See Eisenberg v. Commissioner, 155 F.3d 50, 57 (2d
Cir. 1998), vacating and remanding T.C. Memo. 1997-483; Estate of
Davis v.
Commissioner, supra at 550; Estate of Dailey v.
Commissioner, T.C. Memo. 2001-263; Estate of Borgatello v.
Commissioner, T.C. Memo. 2000-264.
The parties’ experts also apply discounts to LRC’s and LSC’s
net asset values to take into account the estate’s minority LRC
and LSC stock interests and the lack of marketability of those
interests. The minority interest or lack of control involves the
inability to control corporate action, select management,
determine timing and amounts of distributions, arrange financing,
and make decisions about liquidation, merger, and asset sales.
The lack of marketability is based primarily on the fact that
there is no public market for LRC and LSC stock. See Mandelbaum
v. Commissioner, T.C. Memo. 1995-255, affd. without published
opinion 91 F.3d 124 (3d Cir. 1996).
- 21 -
We evaluate the opinions of the expert witnesses in this
case, recognizing each expert’s qualifications, but particularly
in view of the evidence and facts relevant to the estate’s
minority LRC and LSC stock interests. See Parker v.
Commissioner, 86 T.C. 547, 561 (1986).
As stated, the experts agree that as of the valuation date
LRC and LSC net asset values were $33,174,196 and $52,824,413,
respectively. Before discounts that the experts apply, the net
asset values of the estate’s respective 43.1- and 22.96-percent
minority interests in LRC and LSC were $14,298,078 and
$12,128,485.
The following chart summarizes the discounts to LRC’s and
LSC’s net asset values for built-in capital gains taxes, for lack
of control, and for lack of marketability that the estate’s and
respondent’s experts use, and the chart sets forth the experts’
bottom-line opinions of fair market value (FMV) of the estate’s
respective LRC and LSC minority stock interests:
- 22 -
The Estate’s Respondent’s
Expert Expert
LRC
Net asset value $33,174,196 $33,174,196
Net asset value of
estate’s 43.1% interest $14,298,078 $14,298,078
Less discounts for:
Built-in capital
gains taxes 17.4% 2.0%
Lack of control 14.8% 10.0%
Lack of marketability 36.0% 18.0%
Opinion of FMV of
estate’s interest $6,475,000 $10,069,886
The Estate’s Respondent’s
Expert Expert
LSC
Net asset value $52,845,562 $52,845,562
Net asset value of
estate’s 22.96% interest $12,133,341 $12,133,341
Less discounts for:
Built-in capital
gains taxes 23.6% 8.0%
Lack of control 11.9% 5.0%
Lack of marketability 29.7% 10.0%
Opinion of FMV of
estate’s interest $5,748,000 $9,565,535
The parties’ experts are well qualified.
The Estate’s Expert
In calculating his discounts for built-in capital gains
taxes relating to LRC’s and LSC’s appreciated assets, the
estate’s expert, among other things, reviewed minutes of LRC and
- 23 -
LSC board meetings and the history of LRC’s and LSC’s asset
sales, and he talked with LRC’s and LSC’s officers and board of
directors about plans for the sale of LRC’s and LSC’s corporate
assets. The estate’s expert projected holding periods and sale
dates for LRC’s and LSC’s appreciated assets, and he estimated
appreciation for the assets during the holding periods until the
estimated sale dates, calculated the capital gains taxes that
were estimated to be due on the sale of the appreciated assets on
the projected sale dates, discounted to present value the capital
gains taxes so calculated, and subtracted the present value of
the projected capital gains taxes from the net asset values of
LRC and of LSC, respectively.
The estate’s expert’s estimated annual turnover or sale
rates for each class of asset were based on historical asset
sales by LRC and LSC as well as on conversations with LRC’s and
LSC’s officers and directors and minutes from board meetings
indicating an intent to sell some assets in the near future, and
he projected the number of years from the valuation date that
would elapse before LRC’s and LSC’s assets owned on the valuation
date would be sold.
For LRC, the estate’s expert’s asset turnover rate resulted
in a projected average asset holding period of 5 years. As of
the valuation date and using a capital gains tax rate of 38.8
percent, the present value of the estimated capital gains taxes
- 24 -
that likely would be due on LRC’s assets, under the estate’s
expert’s method, was $5,616,085 (17.4 percent of LRC’s net asset
value).
For LSC, the estate’s expert’s 12.5-percent annual turnover
rate resulted in a projected holding period of 8 years and
estimated capital gains taxes of $32,995,835. As of the
valuation date and using a capital gains tax rate of 35.32
percent, the present value of LSC’s estimated capital gains taxes
that likely would be due on LSC’s assets, under the estate’s
expert’s method, was $12,455,695 (23.6 percent of LSC’s net asset
value).
To determine his lack of control discount for the estate’s
43.1-percent stock interest in LRC, the estate’s expert compared
LRC’s securities to closed-end funds7 and compared LRC’s farmland
and other assets to real estate investment trusts (REITs) and
real estate limited partnerships (RELPs). The estate’s expert
reviewed observed lack of control discounts applied to closed-end
fund stock sales as well as to sales of REIT and RELP interests.
The estate’s expert observed lack of control discounts for
closed-end funds of 3.36 percent, with a median of 7.16 percent
and a standard deviation of 17.73 percent. For REITs, lack of
7
Closed-end funds are publicly traded corporations that,
like LSC, invest in securities, pay dividends, and generally do
not issue new shares of stock or redeem outstanding shares of
stock.
- 25 -
control discounts observed ranged from 0 to 38.1 percent over a
10-year period, with the average discount during the year before
the valuation date of 25.5 percent. For RELPs, for lack of
control and lack of marketability a combined mean discount of 25
percent and a range of 10 to 50 percent was observed.
The estate’s expert considered that a 43.1-percent interest
holder would have some ability to force liquidation and to change
LRC’s policy and operation. The estate’s expert considered LRC’s
current financial efficiency as measured by expenses to be
similar to other investments of the same nature. However, the
estate’s expert considered LRC’s historical returns to be
substantially below those of other investments of a similar
nature.
The estate’s expert assigned to each of the above factors a
value between -1 and 1, where -1 represented poor investor rights
and 1 represented excellent investor rights. The factors
regarding ability to force liquidation, ability to change LRC’s
policy and operation, and financial efficiency were each assigned
values of 0 reflecting average investor rights, and the factor
regarding LRC’s historical returns was assigned a value of -1,
reflecting poor investor rights.
Using a formula incorporating the observed lack of control
discounts as well as the above factors relating to LRC (as
represented by their average assigned values) and weighted for
- 26 -
LRC’s combined asset classes, the estate’s expert calculated a
14.8-percent lack of control discount for the estate’s 43.1-
percent stock interest in LRC.
In calculating his lack of control discount for the estate’s
22.96-percent stock interest in LSC, the estate’s expert compared
LSC to closed-end funds and used the observed mean, median, and
standard deviation for lack of control discounts relating to
closed-end fund stock sales.
The estate’s expert considered that a 22.96-interest holder
would have little ability to force liquidation or to change LSC’s
policies and operations. The estate’s expert also considered
LSC’s current financial efficiency and historical returns to be
similar to what a 22.96-interest holder in LSC would expect on
the basis of the behavior of comparable investments.
The estate’s expert assigned to each factor values as
described above. Thus, the factors regarding ability to force
liquidation and to change LSC’s policy and operation were each
assigned values of -.5 reflecting less favorable than average
investor rights, and the factors regarding financial efficiency
and historical returns were each assigned values of 0 reflecting
average investor rights.
Using the above formula, the estate’s expert determined a
lack of control discount for the estate’s LSC stock interest,
unweighted by asset class, of 12.23 percent. The estate’s expert
- 27 -
then reduced the unweighted lack of control discount to account
for LSC’s small percentage of cash and short-term investments,
resulting in an 11.9-percent lack of control discount for the
estate’s 22.96-percent interest in LSC.
In calculating his lack of marketability discount for the
estate’s minority stock interest in LRC, the estate’s expert
compared stock of LRC to restricted stock, including letter
stock,8 and reviewed observed lack of marketability discounts
applied to restricted stock sales. The observed discounts ranged
from 10 to 30 percent for larger companies with profitable
operations and from 30 to 50 percent for small companies with
characteristics indicative of a high degree of risk of loss.
The estate’s expert considered that restrictions on LRC’s
share transferability as well as LRC’s built-in capital gains
would result in a relatively higher discount for lack of
marketability. The estate’s expert also considered expectations
of future cashflow, liquidity of underlying assets, and LRC’s
small size.
The estate’s expert assigned to each of the above factors
values between -1 and 1. However, in his February 2007 report
the estate’s expert did not specify values by factor but instead
gave average values for each class of assets that LRC owned. For
8
Letter stock consists of stock that is restricted from
trading on the open market for a specified period of time.
- 28 -
example, LRC’s cash received an average value of .25, LRC’s
marketable securities received an average value of -.125, and
LRC’s farmland and farmland-related assets received an average
value of -.5.
Using the formula described above, the estate’s expert
calculated a 36-percent lack of marketability discount applicable
to the estate’s LRC stock interest.
In calculating his lack of marketability discount for the
estate’s minority stock interest in LSC, the estate’s expert
compared stock of LSC to restricted stock with observed
marketability discounts ranging from 10 to 30 percent for larger
firms with profitable operations and from 30 to 50 percent for
small companies with characteristics indicative of a high degree
of risk. The estate’s expert considered restrictions on LSC’s
share transferability, expectations of future cashflow, and
liquidity of LSC’s underlying assets.
The estate’s expert assigned to each of the above factors
values between -1 and 1. However, in his February 2007 report
and similar to his treatment of LRC, the estate’s expert did not
specify values by factor but instead gave average values for each
class of assets that LSC owned. For example, LSC’s cash and
short-term investments were assigned a total high average value
of .5, LSC’s marketable securities were assigned a total neutral
- 29 -
average value of 0, and LSC’s venture funds investments were
assigned a low average value of -.25.
Using the formula described above, the estate’s expert
calculated a 29.7-percent lack of marketability discount for the
estate’s 22.96-percent LSC stock interest.9
Respondent’s Expert
In calculating his discounts for built-in capital gains
taxes, for each asset class within LRC and LSC respondent’s
expert used turnover rate estimates based solely on historical
asset sales by LRC and LSC.
Respondent’s expert did not talk to LRC or LSC management.
Respondent’s expert used his turnover rates to project asset
holding periods. Respondent’s expert assumed a capital gains tax
rate effective at the end of the holding period and calculated
capital gains tax due on the assets, and respondent’s expert
discounted back to present value the projected capital gains
taxes, treating the present value of the capital gains taxes as a
liability, subtracting them from net asset values.
For LRC, respondent’s expert’s 1.86-percent asset turnover
rate resulted in a projected asset holding period of 53.76 years.
9
The estate’s expert’s 29.7-percent lack of marketability
discount for the estate’s LSC stock interest is significantly
higher than the 21.4-percent discount therefor that the same
expert witness used in 2000 in valuing for Federal gift tax
purposes the same interest.
- 30 -
Because LRC, as a result of its S election, beginning in 2010
would no longer be required to pay corporate-level capital gains
taxes, respondent’s expert did not include in his calculation of
a capital gains tax discount any capital gains taxes which under
his method were projected to be incurred beyond 2009.
Respondent’s expert multiplied a 38.8-percent capital gains
tax rate by the $8,961,922 capital gains that, as of the
valuation date, would be realized on an immediate sale of LRC’s
assets to yield a capital gains tax of $3,477,226. Respondent’s
expert then discounted a ratable portion of the $3,477,226
capital gains taxes per year for 9 years ($3,477,226 capital
gains taxes divided by 53.76 years equals $64,681 due each year
of the holding period) to yield a present value for the capital
gains taxes of $358,116--an approximate 2-percent discount from
LRC’s net asset value.
For LSC, respondent’s expert’s 3.45-percent asset turnover
rate resulted in a projected asset holding period of 29 years.
Respondent’s expert multiplied a 35.32-percent capital gains tax
rate by the $38,984,854 capital gains that, as of the valuation
date, would be realized on an immediate sale of LSC’s assets to
produce capital gains taxes of $13,769,450. Respondent’s expert
then discounted a ratable portion of the $13,769,450 capital
gains taxes per year for 29 years ($13,769,450 capital gains
taxes divided by 29 years equals $474,809 due each year of the
- 31 -
holding period) to yield a present value for the capital gains
taxes of $4,107,147--an 8-percent discount from LSC’s net asset
value.
Regarding the lack of control and lack of marketability
discounts, respondent’s expert compared LRC and LSC with publicly
traded entities, including those involving restricted stock,
reviewed observed discounts applicable to the sale of interests
in publicly traded entities, and, within a range of observed
discounts that did not include the highest and lowest observed
discounts, adjusted the discounts for LRC and LSC for factors
specific to LRC and LSC.
According to respondent’s expert, a discount for lack of
control generally is required only if the buyer intends to make
changes to the operation of the corporation. Because
respondent’s expert considered LRC’s investments as performing
well, respondent’s expert concluded that a hypothetical buyer
would make few changes to the operation of LRC and therefore that
a buyer would not expect a large discount for lack of control.
In his analysis of LRC’s marketable securities, respondent’s
expert, like the estate’s expert, used closed-end fund data as a
benchmark. However, because the standard deviation applicable to
lack of control discounts for closed-end funds was more than 17
percent and the average discount was only 3.4 percent,
respondent’s expert “trimmed the mean”, or eliminated from his
- 32 -
review the top and bottom 10 percent of observed lack of control
discounts for closed-end funds, resulting in a trimmed average
lack of control discount for closed-end funds of 5.2 percent.
Respondent’s expert did not break down his discount analysis
by asset class, as did the estate’s expert. Instead,
respondent’s expert analyzed LRC’s marketable securities
(including cash and other equity investments) as a whole.
Respondent’s expert considered that a 43-percent interest
holder in LRC would have an above average ability to force
liquidation or to change LRC’s policy and operation. However, as
stated, respondent’s expert also considered that any shareholder
in LRC would place little value on control because a shareholder
would not desire to change operations. Further, respondent’s
expert considered that LRC’s marketable securities yielded very
good returns. Respondent’s expert therefore concluded that a
below-average lack of control discount of 5 percent was
appropriate with regard to LRC’s marketable securities.
With regard to LRC’s farmland and related assets,
respondent’s expert reviewed a variety of published data.
Respondent’s expert noted 17- to 20-percent lack of control
discounts observed in takeovers of public real estate companies,
as reported in Mergerstat Review. In respondent’s expert’s view,
discounts relating to takeovers generally are higher than
discounts for normal sales activity, and the lack of control
- 33 -
discount applicable to LRC’s farmland and related assets should
be lower than discounts reported by Mergerstat Review.
Respondent’s expert determined a 15-percent discount for
lack of control relating to LRC’s farmland and related assets.
Respondent’s expert pointed out that he agreed with the estate’s
expert’s valuation in principle (but not in application) and that
the 15-percent discount respondent’s expert used for LRC’s
farmland and related assets was similar to the 15.7-percent
discount that the estate’s expert derived for the same farm-
related assets of LRC.
Even though LRC’s farmland and related assets constituted
the bulk of LRC’s net asset value, respondent’s expert averaged
the two above discounts to determine his 10-percent lack of
control discount for LRC (i.e., 5 percent for LRC’s marketable
securities plus 15 percent for LRC’s farm-related assets divided
by 2 equals 10 percent).
To calculate a lack of control discount for LSC,
respondent’s expert again used closed-end fund data and a
“trimmed mean” of 5.2 percent. Because the estate’s 22.96-
percent interest in LSC was the single largest block of stock
ownership in LSC, because respondent’s expert considers that a
potential buyer would not want to change the management of LSC,
and because LSC’s returns have been good, respondent’s expert
concluded that a below-average lack of control discount of
- 34 -
5 percent was appropriate for the estate’s interest in LSC. In
essence, respondent’s expert opined that a hypothetical buyer of
a minority interest in a closely held family corporation that is
performing well “would place no value on control” and therefore
that only a nominal lack of control discount should be applied to
the estate’s LSC stock interest.
To determine his lack of marketability discount for the
estate’s LRC stock interest, respondent’s expert compared stock
of LRC to restricted stock and reviewed observed lack of
marketability discounts applied to restricted stock sales
(including three studies of restricted stock sales from the late
1990s that the estate’s expert did not review). Respondent’s
expert determined a 25-percent average observed lack of
marketability discount for restricted stock sales.
Because sale prices for restricted stock may in his view
include factors unrelated to marketability (e.g., liquidity of
underlying assets and corporate distress), respondent’s expert
also reviewed private placement studies that compared discounts
applied to registered, freely tradable private placements and
unregistered, not freely tradable private placements.
Respondent’s expert considered the difference between the
discounts applied to the two types of private placements to be
indicative of a “true” discount for lack of marketability and
- 35 -
determined a range of 7.23 to 17.6 percent in observed lack of
marketability discounts for private placements.
Respondent’s expert then opined that three factors (LRC’s
dividend paying policy, the ability of a 43.1-percent interest
holder in LRC to affect management, and the small likelihood that
LRC would incur the cost of an initial public offering) suggested
that a lack of marketability discount for the estate’s interest
in LRC should be below average.
Respondent’s expert opined that an additional five factors
(the slight difficulty an investor would encounter in determining
LRC’s net asset value, LRC’s likelihood of continued returns,
LRC’s low management fees, the holding period necessary for LRC
to be able to sell farmland and related assets, and LRC’s
willingness to redeem stock but potential inability to do so due
to taxes that would be due on redemption) suggested a
marketability discount that was only average but that LRC’s
restrictions on stock transferability suggested an above-average
lack of marketability discount.
Using benchmarks established by restricted stock and private
placement sales studies and adjusting for the above factors,
respondent’s expert determined that 18 percent was a reasonable
below-average lack of marketability discount for the estate’s
shares of stock in LRC.
- 36 -
To determine a lack of marketability discount for the
estate’s minority stock interest in LSC, respondent’s expert
reviewed the same restricted stock and private placement data
referred to above. Because LSC’s assets consisted mainly of
marketable securities whose values were readily ascertainable and
salable, respondent’s expert opined that a lack of marketability
discount should be average or below average.
Further, respondent’s expert opined that LSC’s policy of
paying dividends, LSC’s transparent financial conditions, LSC’s
long history of investments that provided returns, LSC’s low
management fees and competent management, the lack of formal
legal restrictions on transferability of shares of stock, and the
small likelihood that LSC would incur the cost of an initial
public offering in the future all suggested that the lack of
marketability discount for LSC should be below average.
Respondent’s expert concluded that 10 percent was a reasonable
below-average lack of marketability discount to apply to the
estate’s shares of stock in LSC.
Analysis
On the facts and evidence before us, with regard to the
built-in capital gains tax discounts, in view of the asset
- 37 -
valuation method employed by the parties and their experts, the
highly appreciated nonoperating investment assets held by LRC and
LSC as of the valuation date, and the C corporate tax liabilities
to which LRC and LSC remain subject, we consider it likely that a
willing buyer and a willing seller would negotiate and agree to
significant discounts to net asset values relating to the
estimated corporate capital gains taxes that would be due on the
sale of LRC’s and LSC’s nonoperating assets.10
10
Under the asset approach to the valuation of appreciated
C corporation nonoperating assets, valuation discounts (apart
from discounts for lack of control and marketability) for
estimated built-in capital gains taxes have been the subject of
much litigation. For cases denying built-in capital gains tax
discounts for years before 1986, when former secs. 336 and 337
made imposition of capital gains taxes on appreciated corporate
assets speculative, see, for example, Estate of Piper v.
Commissioner, 72 T.C. 1062, 1087 (1979) and Estate of Cruikshank
v. Commissioner,
9 T.C. 162, 165 (1947).
For cases allowing built-in capital gains tax discounts for
years after amendment in 1986 of secs. 311, 336, and 337 by the
Tax Reform Act of 1986, Pub. L. 99-514, sec. 631, 100 Stat.
2269, under which corporations no longer could readily avoid
capital gains taxes on appreciated assets, see, for example,
Estate of Jelke v. Commissioner, 507 F.3d 1317 (11th Cir. 2007);
Estate of Dunn v. Commissioner,
301 F.3d 339, 354 (5th Cir.
2002), revg. T.C. Memo. 2000-12, Estate of Jameson v.
Commissioner,
267 F.3d 366, 371-372 (5th Cir. 2001), vacating and
remanding T.C. Memo. 1999-43, Eisenberg v. Commissioner,
155 F.3d
50, 57-58 (2d Cir. 1998), vacating and remanding T.C. Memo. 1997-
483, Estate of Davis v. Commissioner,
110 T.C. 530 (1998), Estate
of Dailey v. Commissioner, T.C. Memo. 2001-263, and Estate of
Borgatello v. Commissioner, T.C. Memo. 2000-264.
(continued...)
- 38 -
The estate’s expert’s assumptions relating to asset turnover
estimates were based on more accurate data (namely, historical
data, recent data, and conversations with management) than were
respondent’s expert’s assumptions (namely, historical data and
wrong assumptions as to management’s plans).
As indicated, the estate’s expert and respondent’s expert
projected that a certain percentage of LRC’s assets, using their
turnover estimates, would be sold each year. The estate’s
expert’s projections for LRC of an average asset holding period
10
(...continued)
In Estate of Jelke v. Commissioner, 507 F.3d at 1331, the
U.S. Court of Appeals for the Eleventh Circuit held that--using
the net asset method to value closely held C corporation stock
and regardless of whether a sale or liquidation of corporate
investment assets was contemplated as of the valuation date--an
assumption, as a matter of law, was appropriate that all
corporate investment nonoperating assets would be liquidated on
the valuation date and therefore that a built-in capital gains
tax discount equal to 100 percent of the built-in capital gains
taxes that would be due on a sale of the appreciated assets
should be allowed. To the same effect see the opinion of the
United States Court of Appeals for the Fifth Circuit in Estate of
Dunn v.
Commissioner, supra at 352-353.
Herein, the estate’s expert does not assume that LRC’s and
LSC’s appreciated, nonoperating assets would be sold on the
valuation date, and the estate does not ask us to apply a full
dollar-for-dollar valuation discount for estimated built-in
capital gains taxes. Therefore, we need not decide herein
whether such an approach would be appropriate in another case
where that argument is made.
- 39 -
of 5 years and for LSC a holding period of 8 years were based on
historical asset sales and conversations with LRC management
about potential asset sales in later years.11
Respondent’s expert also projects that LRC’s and LSC’s
corporate assets will be held for and sold off over a period of
years, and respondent’s expert discounts to present value, as of
the valuation date, those estimated capital gains taxes, but
respondent’s expert does not take into account appreciation
during the holding period that also likely will occur and that
will be subject to taxes at the corporate level--what one expert
has described as the tax-inefficient entity drag. See Johnson &
11
Under the estate’s expert’s turnover estimates for LRC
(which we find credible and reasonable on the facts) LRC’s assets
owned on the valuation date are treated as sold during the period
in which LRC will still owe corporate-level taxes on the sale of
assets and therefore a built-in capital gains tax discount for
LRC is appropriate. The facts herein are unique and not all
S corporations will be allowed a built-in capital gains tax
discount. See Dallas v. Commissioner, T.C. Memo. 2006-212.
Regarding LSC, the estate’s expert’s calculation of the
built-in capital gains tax discount assumed a sale of assets in
year 8 for ease of explanation. If the estate’s expert had made
his capital gains tax calculation using a sale of 12.5 percent of
LSC assets in each of years 1 through 8 after the valuation date,
his calculation would have been more consistent with his
projection of asset turnover (i.e., 12.5 percent of assets sold
in each year resulting in a final asset sale in year 8) and also
would have resulted in a slightly increased built-in capital
gains tax discount. We find no significant flaw in the estate’s
expert’s simplification.
- 40 -
Barber, "Tax-Inefficient Entity Discount", 6 Valuation Strategies
20, 46 (Mar./Apr. 2003). On the facts presented to us, we
believe that, as of the valuation date, a hypothetical buyer of
LRC and LSC stock would attempt to estimate this extra corporate
level tax burden on holding-period asset appreciation and would
include the estimated cost or present value thereof in a built-in
capital gains discount that would be negotiated between the
hypothetical buyer and seller. We accept the estate’s expert’s
estimates of his built-in capital gains discounts for LRC and
LSC.12
With regard to the estate’s LRC and LSC stock interests and
on the basis of all of the facts and evidence before us, we
conclude that the estate’s 17.4 and 23.6 percent built-in capital
12
One of respondent’s own experts in another case
acknowledges that he also would take into account holding-period
asset appreciation in calculating appropriate valuation discounts
to net asset value. See Estate of Dailey v. Commissioner, T.C.
Memo. 2001-263. Also, in Estate of Borgatello v. Commissioner,
supra, the parties included in their calculations of a built-in
capital gains tax discount, and the Court included in its
calculation thereof, estimated holding period asset appreciation
and capital gains taxes thereon. We note that in Estate of Jelke
v. Commissioner, T.C. Memo. 2005-131, the methodology used by the
Court to calculate a discount for built-in capital gains taxes
did not include holding-period asset appreciation. However, in
Jelke the Court also emphasized the factual nature of the
calculation of discounts for built-in capital gains taxes in a
particular case and expressly stated that a valuation methodology
used in one case was not binding on the Court in another case.
- 41 -
gains tax discounts are appropriate with respect to the estate’s
interests in LRC and LSC, respectively.
With regard to the lack of control discount for LRC, we note
that both experts, using slightly different data sets, calculated
similar lack of control discounts for LRC’s farmland and related
assets (the estate’s expert--15.7 percent; respondent’s expert--
15 percent) and that both experts used lack of control discounts
for LRC’s securities lower than the lack of control discounts for
LRC’s farmland and related assets.
Both experts averaged their discounts for the farmland and
for the securities to determine a lack of control discount for
the estate’s LRC stock interest. The estate’s expert used a
weighted average to account for the fact the LRC has
significantly more farmland than securities. In contrast,
respondent’s expert used a straight average.
A straight average would have been appropriate if LRC’s
farmland and securities holdings were roughly equivalent.
However, LRC’s securities constituted a significantly smaller
portion of LRC’s total assets. If respondent’s expert had
accounted for LRC’s unequal mix of assets by using a weighted
average, respondent’s expert’s lack of control discount would
- 42 -
have been more applicable to LRC (and would have been closer to
the estate’s expert’s 14.8-percent lack of control discount).
We conclude that the estate’s expert’s 14.8-percent lack of
control discount for the estate’s LRC minority stock interest is
appropriate.
With regard to the lack of control discount for the estate’s
LSC stock interest, respondent’s expert applied the same 5-
percent discount as he applied to LRC’s securities portfolio even
though the estate’s 22.96-percent stock interest in LSC was much
smaller than the estate’s 43.1-percent stock interest in LRC,
whereas, the estate’s expert used an increased lack of control
discount for LSC (relative to the same type of assets--
securities) to take into account the estate’s smaller stock
interest in LSC.
We conclude that the estate’s 11.9-percent lack of control
discount for the estate’s minority stock interest in LSC is
appropriate.
With regard to the lack of marketability discounts for both
LRC and LSC, we consider it appropriate to weigh the assets by
class. We, however, regard the estate’s expert’s respective 36-
percent and 29.7-percent lack of marketability discounts,
particularly when combined with the 14.8- and 11.9-percent lack
- 43 -
of control discounts we allow, to be high. The estate’s expert
used some outdated data relating to restricted stock discounts.
His discounts are higher than marketability discounts reflected
in benchmark studies that included all components of a lack of
marketability discount.
We also note that the estate’s expert opined in another
valuation report prepared for Federal gift tax purposes in March
of 2000 that the estate’s same 22.96-percent LSC minority stock
interest was appropriately discounted for lack of marketability
by 21.4 percent, significantly lower than the 29.7-percent lack
of marketability discount he suggests herein and corroborative of
the lack of marketability discount we conclude is appropriate.
We conclude that discounts for lack of marketability of 25
percent and 20 percent should apply to the estate’s respective
LRC and LSC minority stock interests.
The chart below summarizes the discounts for built-in
capital gains taxes, for lack of control, and for lack of
marketability that we find to be appropriate on the basis of the
evidence and taking into account respondent’s burden of proof in
this case on these factual valuation issues--and our calculations
of the respective $7,546,725 and $6,530,790 fair market values of
- 44 -
the estate’s 43.1- and 22.96-percent respective LRC and LSC stock
interests:13
LRC
Net asset value $33,174,196
Net asset value of
estate’s 43.1% interest $14,298,078
Less discounts for:
Built-in capital gains taxes 17.4%
Lack of control 14.8%
Lack of marketability 25.0%
FMV of estate’s
interest $7,546,725
LSC
Net asset value $52,845,562
Net asset value of
estate’s 22.96% interest $12,133,341
Less discounts for:
Built-in capital gains taxes 23.6%
Lack of control 11.9%
Lack of marketability 20.0%
FMV of estate’s
interest $6,530,790
To reflect the foregoing,
Decision will be entered
under Rule 155.
13
As stated, the issues presented to us are the appropriate
amounts of the respective three discounts. The precise
mathematical application of the three discounts that we conclude
are appropriate to the estate’s shares of the net asset values of
LRC and LSC is subject to the parties’ Rule 155 calculations.
